Beware of the Stock Market as a Self-Fulfilling Prophecy

by Hank Coleman

In many ways the stock market is a self-fulfilling prophecy. When investors buy into a certain philosophy or thought about where the market is heading, the stock market tends to go in that direction. We must all be conscience of how market sentiment affects our investments.

crystal_ballA self-fulfilling prophecy is when positive or negative expectations about circumstances, events, people, companies, or investments that may affect an investor’s behavior toward them in a manner that he or she unknowingly creates situations in which those expectations are fulfilled. A self-fulfilling prophecy is a statement that alters actions and therefore forces itself to come true.

Panic Selling.  When things are going bad, investors naturally get scared.  Scared investors usually end up selling their stock and mutual funds.  That selling pushes the price of the investment lower thanks to supply and demand just like the investor thought it would. If enough investors get together and think the same things, then those types of market moves will happen.

Riding High.  Everyone wants their investments to perform well. Everyone wants to earn money in the stock market. It is this want that drives a lot of the stock and mutual fund prices higher.  Momentum trading is a self-fulfilling action in and of itself. If investors believe that a past price change in the stock market is informative of future price changes and act on this belief, it will be true and trading on this belief will be profitable.  Because of the laws of supply and demand, buying stock will inevitably raise the demand for that stock and prices will rise just like the investor thought they would.

Examples of self-fulfilling prophecy in investing abound.  In the stock market, for example, when investors think they have clues to stocks that are hidden treasures, many act on those hot stock tips even though they are really not more than just mere speculation. Since no one wants to miss a great investing opportunity, those investors who received the hot stock tip start buying and spreading the word to all their friends. Now, you have a buying spree on your hands. As more people buy a stock that is limited by definition in supply, the stock’s price rises. This confirms that the tip was accurate to the investors even though there may have been no truth behind it all.

So, what does this all mean? Be careful if you find yourself getting too emotional about stocks, mutual funds, and investing. And, remember to factor in people’s expectations when investing as well.  What you and the crowd expects to happen often does thanks to the stock market’s tendency to be a self-fulfilling prophecy.

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{ 1 comment… read it below or add one }

Christina December 18, 2009 at 2:04 am

“Panic Selling” is the usual tendency of amateur investors…sound advice.

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